My friend Jen writes about informal labor markets in South Africa. She was telling me the other day about street vendors who make their living buying packs of a dozen pairs of socks and selling them pair by pair. In that same spirit of finding a niche in the very last step of the distribution network, I thought I would pass on some material from a talk I attended last week by Sir Howard Davies. It's below the fold, with occasional comments from me in brackets. A lot may seem familiar, but enough was new to me -- and Davies is high enough up in this world; he'd had dinner the night before with Charles Dallara -- that I think it's worthwhile to put down my notes in full.
There are six and half questions to ask about the Euro system. Is the crisis over? Why did anyone think it would work? Why did it take so long to fall apart? Are the responses to date sufficient? What more is needed? Why even bother? And the half question, what's it all mean for the UK?
To question 1, no surprise, the answer is No. "The ECB has been making really good policy for a country that doesn't exist." The fundamental problem of pan-European banks with no pan-European regulator or lender of last resort is no closer to being resolved; "some sticking-plaster has been applied," that's all.
On question 2, there were three reasons:
Some people said, "Yes, you will need a fiscal authority, but it will happen." Europe policy in general has developed through a process of leap forward, then retrofit. And after all, it says right in the treaty "Ever closer union."
Other people thought the stability and growth pact would ensure appropriate policy.
A third group of people, including Davies, believed something like, "Yes, these economies are very different, with different labor market institutions and so on, but without the option of devaluation they will be forced to converge." Periodic devaluations had allowed southern European countries to avoid structural reform, but now everyone would have to behave like the Germans.
Well, all these views were wrong. Why? Three reasons:
- Maastricht turned out to be the high point of enthusiasm for federalism. Every single vote on additional federalism has said, No.
- The SGP turned out to be both too tight, in that it didn't leave enough space for countercyclical fiscal policy, and too loose, in that it had no enforcement mechanism. [So it sounds like Davies would be on board with John Quiggin's "hard Keynesianism."]
- Lower interest rates were not used for fiscal consolidation. [This seems wrong to me, at least for Italy and Spain.] And there was no convergence to German levels of productivity.
On question 3, the first answer was that the first decade of the euro was, in Mervyn King's unfelicitous coinage, NICE -- Non-Inflationary with Consistent Expansion. And the ECB, while prohibited from buying government bonds directly, bought them in secondary markets at equal rates, meaning there was no pressure for fiscal discipline on member states. [Again, I'm resistant to this story, except for Greece and maybe Portugal.] Davies recalls talking to a Morgan Stanley bond dude, explaining how he marketed Greek debt: "A Greek bond is just like a German bund, except with an extra three points of interest." There was a real market failure here, says Davies, and the banks that ended up holding this stuff (all European, by the way, American institutions have successfully elimianted almost all their exposure) deserve their haircuts.
[It would be interesting to explore the idea that an unsustainable current account deficit is precisely one that can only be financed with an interest rate premium.]
Question 4, the adequacy of the response. "The problem is that they are focused on the last crisis and the next crisis, but not on the current crisis." By which he means that they are putting in place rules that would have helped if they'd already been in place years ago, while ignoring the ways in which "responsible" fiscal policy will exacerbate the current downturn. The problem right now is that austerity just makes the growth picture worse, and that the European "rescue capacity" is too small.
Question 5, what more is needed. In the short run, a better firewall is needed to prevent contagion from the worst-hit countries and institutions. In the longer run, Europe needs (a) some system for Europe-wide public borrowing (one idea would be for debt up to, but not above, the SGP levels to be backed by the community as a whole); and (b) a pan-European bank regulator and lender of last resort. But the Germans won't go for it.
Which brings us to Question 6. Wouldn't some countries be better off leaving? Greece's departure is probably inevitable, he said. But it poses major challenges -- even if you had an agreed-on procedure for converting Greek euros to the new Greek currency, which euros are the Greek ones? "If the coin says Greece, no problem. Greek government bonds, ok, those are Greek. And if you are living in Greece and have an account in a Greek bank, then that is probably a Greek euro. But, I have a boat in Greece and an account at Barclay's in Athens. Are those Greek euros? I hope not. How about someone living in Athens but with a bank account in London, is that a Greek euro?" And beyond those technical problems, there are even worse political problems, that should make exit the last possible resort. Because, who will benefit from the failure of the euro, politically? In France, the fascists -- Marie le Pen based her whole campaign around it. "In Greece, it would be the anarchists and the communists, they're the only ones who have been against the euro." [OH NOES the anarchists.] The communists in Hungary, Sinn Fein in Ireland, etc. "Only in the UK can you say that the Euro-skeptics are not mad people."
Nonetheless, Greek exit is probably unavoidable. "My hunch is that Greece will not make it," because they lack social capital. The Irish are stoic, they will accept lower pay and higher taxes. They say, ah well, we had a good few years but it had to end. Not the Greeks, they won't pay taxes. [There was a shaggy-dog story in here about local officials in Spain and Greece competing to see who can waste more EU money.] Gas costs $6 a gallon in Greece because it's almost the only thing the government can reliably tax. "Latvia could make austerity work because they'd been in the USSR for 50 years, they were used to unpleasant and dramatic things happening. The population would accept incredible privation." The Greek population, sadly, will not.
And on the last half question: If the solution is "more Europe," that will be a big problem for the UK. Cameron is a Euro-skeptic; it's not just because he's responding to popular opinion, but nonetheless popular opinion is heading that way. The UK is going to face increasing pressure to detach itself from the EU.
And a few other observations, from the Q&A:
"You can't imagine Italy having an unelected government for long, but they are urgently engaged in some necessary reforms that would otherwise be impossible."
There has never been a referendum in favor of the euro.
German wages have not gone up, German property values have not gone up, why should ordinary Germans feel like they are the beneficiaries of the euro and want to do more to save it? [Sounds like an argument for Thomas “Drink finer wines, drive nicer cars, and party harder!” platform.]
Most likely, Greece will have a disorderly exit, and that will concentrate the minds of European policymakers to take the necessary steps to prevent a repeat. Avoiding future defaults will require some kind of collective guarantee of Euro-area bonds, but Germans won't accept that until it's clear that the altenrative is catastrophe. So, "Greece may have to perform this service."
The alternative is for Greece to do what Latvia did, structural reforms, get rid of anti-competitive policies. The problem is, you don't have a full technocratic government in Greece, you still have elected officials with real power. [And that, I think, is what it all comes down to.]